Tuesday, September 30, 2008

[Readers' comments would be most helpful here. I'm not at all sure whether I've missed detail or misrepresented some facts relating to the Term Auction Facility. Here's what I've pieced together today.]

The Term Auction Facility is an emergency provision implemented by the US Federal Reserve last December to address the freezing up of interbank lending during the so-called 'credit crisis'. The banks weren't - and aren't - using the existing 'discount window', which is the emergency facility traditionally provided. This was happening even after the Fed had dropped the rate charged. There was a lack of liquidity and something had to be done quickly.

"Lenders [were] hoarding cash and shunning their peers as if they were all lepers." [1] Banks had failed to mark their securities to market and there didn't appear to be any practical way to assess the real value of their assets and liabilities. Suspicions were very high after many years of unregulated/deregulated and lax lending practices. At that stage it appeared that all the good collateral of the banks had been pledged and what was left to lend against wasn't worth having.

"In the Federal Funds market the Fed, along with the Bank of Canada, Bank of England, the European Central Bank and the Swiss National Bank, decided to implement a new monetary instrument.... This program, known in the US as the Term Auction Facility, enables the Fed to auction a set amount of funds to depository institutions, against a wide range of collateral."[2] The financial press reassured the public that the 'collateral' was of good quality and had triple A ratings from respectable firms such as Standard and Poors and Moodys. The trouble was that the rating agencies themselves had given over to the free-for-all spirit and their standards had plummeted also.

In the middle of February this year - for the first time ever - "the banking system showed negative net non-borrowed reserves" in the US [3]. The banks were exploiting the Term Auction Facility as much as they could for a range of reasons. This was a sign of continuing distress in the financial market. The funding was cheaper than elsewhere provided. There were continuing difficulties raising funds from other sources. The collateral problems were bad and appeared to be getting worse under this new program. The bankers' greater reliance on government support resulted in the central banks increasing the amount of money they were using to fund the facility to the tune of hundreds of billions of dollars. The system lacks transparency. The public don't know who submitted the collateral. The banks are distorting their behaviour; they appear to have long begun to create Residential Mortgage-Backed Securities "and keeping them on the banks books as a quick way, in another liquidity squeeze like August [2007], to access ECB/FED liquidity." [4]

The trouble is that the assets involved in these auctions have still not been appropriately valued. The solvency of the institutions involved is unknown. The true situation appears to be coming to light only after the bank is formally declared bankrupt. The public are left liable and extremely vulnerable as the Fed and other central banks accrue more and more worthless or low-value collateral.

Last night the US Fed announced that TAF "will expand by $300 billion to $450 billion." [5] Under the circumstances described above this is, in effect, a massive bailout of these institutions by stealth.

“If all the bank loans were paid up, no one would have a bank deposit, and there would not be a dollar of currency or coin in circulation. This is a staggering thought. We are completely dependent on the commercial banks for our money. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money, we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp upon the picture, the tragic absurdity of our hopeless position is almost incredible - but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it is widely understood and the defects remedied very soon.” - Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta

[1] Crisis may make 1929 look a 'walk in the park'. By Ambrose Evans-Pritchard. Last Updated: 11:02pm GMT 23/12/2007. http://www.telegraph.co.uk

[2] Term auction facilityFrom Wikipedia, on 29th September 2008http://en.wikipedia.org/wiki/Term_auction_facility

1990 – 1992 era. The changes began then that led to the elimination of the reserve requirement.

1992 The Fed Reserve ratios were lowered.

1995 – The US Federal Reserve effectively eliminated the fractional reserve ratio. Banks were no longer required to back assets that largely corresponded with “broad money” (M3) with cash reserves. The consequence was that banks could effectively create money without limitation. From early 1994 to late 1996, most of the remaining reserve deposits disappeared. "This transformation of banking practices seems to have started small, but really picked up steam by 1996 and 1997, likely due to competitive pressures among banks; those banks that used these methods could easily out-compete those that did not."[1]

1995 – US Fed and other central banks printing money like confetti….It is reasonable to suppose that such a gigantic increase in money supply would produce price rises in assets, housing and commodities BUT consumer price inflation remained under control. Why? Rapid growth of India and China (source of cheap labour)? Internet and telecommunications revolution rapidly improved the cost structures of existing products? Labour-free productivity of manufacturing. The stepping up of the rate of environmental rape (mining of raw materials and forests) associated with industrial production? The WTO established. 1995 Dow First close above 5000. Stock Market Keynesianism. Never before had a US economic expansion become so dependent on the ascent of the stockmarket.

Mid 1990s – the collapse of the First Italian Republic. It involved large-scale criminal influence in government and originated as an American parapolitical operation.

1995 – 1999 – The vice president of the Bank of New York sets up illegal accounts to facilitate the movement of funds into and out of Russia. Her crimes of money laundering did not result in a sentencing for her.

1995 – 2001 – the dot com speculative bubble.

1990 – 2005 – doubling of the global workforce

1995 – 2005 – about 3.2 million US homeowners bought houses on the basis of subprime mortgages or similar credit terms

1995 – 2005 Global ‘Savings’?? Glut. “..a remarkable reversal in the flows of credit to developing and emerging-market economies, a shift that has transformed those economies from borrowers on international capital markets to large net lenders…” (Ben Bernanke in 2005)

[1] What (Really) Happened in 1995? How the Greenspan Fed Screwed Up in the Mid-90s and set the stage for the Greatest Financial Bubble in the History of the World. By Aaron Krowne

Also see: ‘Made in U.S.A. 1995’ by Eric Janszen. March 22, 2006http://www.itulip.com/forums/showthread.php?p=1495

Sunday, September 28, 2008

A financial bailout could worsen the crisis, be insufficient to restore trust and cost ‘a few’ billion dollars a year to administer said Peter R Orszag, US Congressional Budget Office Director, in his testimony before the House Budget Committee. The key question he said what “What are we buying and what are we paying for it?" Orszag feared that the bailout as it stands might reveal that the large financial corporations are inflating prices of assets on their books. “Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.” Such corporations "look solvent today only because it's kind of hidden” [but they] “actually are insolvent".

Here's what I don't understand: Because short-term lending by the banks had almost completely shut down Treasury is acting as a go-between in short-term lending between banks. "Instead of Bank A lending directly to Bank B, as is customary, Bank A [purportedly] no longer had confidence that Bank B could repay the loan. So Bank A would give the money to the Treasury, which issued a security that was put into the Federal Reserve, which then issued the cash to Bank B." [That action implies that the US Government is already guaranteeing the debt of insolvent firms; already bailing them out. Is that correct?]Bailout Could Deepen Crisis, CBO Chief SaysAsset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells CongressBy Frank Ahrens, Washington Post Staff Writer. Thursday, September 25, 2008; D04http://www.washingtonpost.com/wp-dyn/content/article/2008/09/24/AR2008092402799_pf.html

Saturday, September 27, 2008

Both McCain and Obama are effectively running against Bush, but neither is able to frame his argument in a coherent way. That is, we have criticisms of this policy or that one, but no general position that ties them together and makes them look like anything more than random corrections. McCain’s problem is obvious—he’s really running against his party (the “maverick” trope)—but what about Obama?

Republicans have put forward different frames over recent years, but two are central to actual policy: free-market economics and the unrestricted, hegemonic use of police and military power (“standing tall”, “keeping us safe”). You could say that the current financial crisis blows away the first and that Iraq discredited the second. So this is an opportunity for the Democrats to engage in a little frame replacement to their own advantage. Instead, what do we get?

Obama talks about the Iraq disaster in an apolitical fashion, as a simple error in judgment. As one who saw through the bs from the beginning, he claims to have superior judgment compared to someone like McCain. What’s missing, however, is how his rejection of Bush’s war reflects a broader position on military and foreign policy. No doubt he is afraid of being labeled “soft”, and this explains his reckless belligerence regarding Pakistan. Yet it would not be very difficult to construct a politically saleable alternative to the shoot’em up philosophy of Bush/McCain.

You’d think he would do better on the economic side. The lessons of the financial mess are straightforward and lend themselves to a reframing of the public role in directing the economy. Still, Obama goes only halfway. He talks repeatedly of the “failed philosophy of the last eight years”, but he says nothing about what the new philosophy should be.

A failure to frame is politically disabling on multiple levels. It cedes too much of the political turf from the outset, and does nothing to predispose the voters to support you. It means that every policy initiative has to start from zero, with no ideological headstart. Above all, it represents an abandonment of the leadership role of politics, the struggle to change the political center of gravity. If one side hammers relentlessly on its frames and the other talks about competence and judgment—well, we know what you get.

There is no evidence at this point that the Democrats are prepared to conduct a political fight in broad daylight to change the direction of this country.

I’ve been thinking mostly about the global portion of the loop—how the dollars we send abroad on the current account (and now, just a bit, on net private capital outflows) are returned to us—and its operation under the Paulson plan. The Fed/Treasury team is proposing to allow this recycling to proceed under an asset cleansing program: the Fed removes the bad assets from our creditors’ portfolios while the Treasury replaces them with nice, reliable T-bills. (Metaphor: TARP as a giant mollusk in the sea of finance.) So far so good.

But this is only part of the picture. The other part is the domestic sector. Our current account deficit says that, as a country, we consume about 6% more than we produce, where “consume” in this context means total demand and not just the household piece of it. So the recycling process has to actually get the money into the hands of those who will spend it. This means credit expansion of some form. To be more specific, capital spending is very weak at present, and households are now holding up the tent. They have been borrowing against largely fictitious real estate equity and, to a lesser extent, running up credit cards and drawing down savings. If the popping of the housing bubble and the retrenchment of consumer credit mean that these channels are no longer available, how do we keep the engines running?

Basically, there are two channels still open: fiscal deficits and further drawdowns of savings. In the case of the former, it is important to be able to identify how the deficits will enter the spending stream. I worry that much of the eleven-figure disbursement will simply keep financial institutions, now highly risk-averse, afloat. This maintains existing wealth for the small minority that holds most of it, but it doesn’t translate into effective demand. And eating up savings can go only so far. Say what you want, the asset bubble(s) promulgated by earlier rounds of recycling at least propped up domestic spending. I worry that, even if the bailout keeps the global loop in operation, it will not be able to reconnect it to the domestic loop. The result will be a monster recession.

Non-financial blue chip corporations are having difficulties raising money in the commercial paper market, along with their financial counterparts. They are now borrowing from banks at higher rates. Of course, many banks have high levels of investment in these same corporations and this suggests that, in reality, corporations outside of the large global conglomerates are the ones left without any real defence.

Interbank lending has shut down. Oligopoly banks with interlocking directorates and interlocking ownerships with the big 500 are not trading with each other. Are they also refusing to trade with their own global financial subsidiaries? If the latter statement is true the irony is stark, along with the economic repercussions. Intracorporate trade now makes up such a huge percentage of global economic transactions and this fact makes the unfolding crisis without modern historical precedent.[2]

Privately-owned central banks and public treasury officials have not been prepared to seize and shut down insolvent firms. The emphasis has been on financial bailouts rather than control of the outcome. It’s a panic and the risk has increased. Large private lenders with significant control in the overnight market are demanding higher compensation. (A billion dollars lent overnight at the US Fed rate (2%) yields only about $55,000, an amount deemed insufficient in today’s risky environment)[3].

In 1930 the private central banks increased the monetary base but with these same banks being insolvent and funds being withdrawn by worried depositors, money supply contracted regardless. ($16 billion was withdrawn from WaMu before it went down, according to Bloomberg [4].) What percentage of deposits went out of the banking system? How much was converted to cash and gold and how much was capital flight? What research has been done on this?

The determinants of how the crisis plays out go beyond the actions of financial and political authorities. Investor and consumer action will shape its evolution as well.

If central banks (i.e. the conglomerate of major private banking firms accessing taxpayer funds) continue to lend below-market rate (to themselves) the taxpayer will remain the only source of capital.

The taxpayer needs to insist that their lending is backed up by equity in these ‘private’ firms and be prepared shut them down quickly if they are now insolvent. The transition from publicly-funded ‘private’ banks to publicly-funded ‘public’ banks is not a big one.

[1] As cited by Juan Falcone on Naked Capitalism's "Europe Opens Ugly" as published on 26th September 2008.

[2] "Giant multinational corporations dominate the area of international exchange and a very large share of world ‘trade’ is actually between branches of these same corporations. In North America trade associated with U.S. parent multinationals or their foreign affiliates accounted for 54 percent of U.S. exports of goods and 36 percent of imports.[2] Forty percent of trade between the US and Canada in 1998 was intra-corporate.[3]. “Forty percent of the US-Europe trade is between parent firms and their affiliates, and in respect of Japan and Europe, it is 55 per cent; with regard to US-Japan trade, it is 80 %.”From 'General Concept of Transfer Pricing'.By Khurram Khan. [t-price.pdf]http://www.hmaconsultants.com/pdf/t-price.pdf As cited in 'It's not international trade. Don't be fooled', Brenda Rosser. 24th July 2008

[3] Juan Falcone on Naked Capitalism's "Europe Opens Ugly" as published on 26th September 2008.

[4] Juan Falcone on Naked Capitalism's "Europe Opens Ugly" as published on 26th September 2008.

Wikipedia: Hustling is the deceptive act of disguising one's skill in a sport or game with the intent of luring someone of probably lesser skill into gambling (or gambling for higher than current stakes) with the hustler, as a form of confidence trick.... A skilled hustler may pretend to be intoxicated, unintelligent, or otherwise impaired (that is, until it is time to run the table or make a game-winning shot).

What if Governor Palin has been coached to deliberately low-ball her interview performances with Charlie Gibson and Katie Couric so that she can pull a stunning reversal during the vice-presidential debate and come off as (comparatively) sharp, knowledgeable and articulate?

Thursday, September 25, 2008

Give George Bush credit. He is managing to shut down the flow of illegal immigration. Of course, he did it by trashing the economy, but now people are not as enthusiastic about coming to work in the United States.

A RUMOUR: Chinese regulators have told domestic banks to stop interbank lending to U.S. financial institutions to prevent possible losses during the financial crisis. [1] There's talk that Chinese authorities have since denied this claim.

China is worried about the default risk on its loans to the US. The nation is also losing on the principal value of its borrowings to the US because of the steady revaluation of the Yuan. (This revaluation has been done, whether justified or not, as a result of pressure from the US).

The Paulson plan is expected to inject $700 billion into (private) banks. This financial capital is then expected to be used by (for profit) banks to create up to 14 trillion dollars credit to buy the quantity of extra treasuries that will go onto the market. I don't see why a nationalised bank can't perform this function?

Some leading financial authorities in China want the Asian nations to agree to refrain from panic selling of US treasury securities in order to prevent a free-fall in their value. Such an agreement is unlikely given the history of wars and antagonism between the various nations.

Whatever the outcome of this immediate saga it is almost certain (IMHO) that China's 'export-growth strategy' will come to an end. That will be a day for the forests and planet earth to celebrate![1] http://www.reuters.com/article/companyNewsAndPR/idUSPEK16693720080925

These guys are just digging into such depths of nonsense and desperation that pretty soon they're going to pop out in China, which will be helpful since they can ask the Chinese for the trillion dollars it'll take to bail out McCain's pals on Wall Street for the mess his economics advisor Phil Gramm made possible. Here's the latest attempt to exploit the financial market crisis for political ends (from CNN)...

McCain supporter Sen. Lindsey Graham tells CNN the McCain campaign is proposing to the Presidential Debate Commission and the Obama camp that if there's no bailout deal by Friday, the first presidential debate should take the place of the VP debate, currently scheduled for next Thursday, October 2 in St. Louis.

So we need to put the country first and cancel the vice presidential debate.

The New York Times reported Monday, “Mr. Paulson said that he was concerned that imposing limits on the compensation of executives could discourage companies from participating in the program.

“’If we design it so it’s punitive and so institutions aren’t going to participate, this won’t work the way we need it to work,’ Mr. Paulson said...” [1]

And

"Bernanke wants government [taxpayer] to pay significant premium over current "firesale" price for troubled assets. Specifically, he wants to pay close to the "hold-to-maturity" price, which he argues is much higher than the mark-to-market firesale price. Bernanke and Paulson believes this is necessary to get banks to participate." [2]

Apart from feathering the next of his colleagues, don't you get the impression that Paulson is hiding something? After all the Paulson bailout plan has been extended to the financial securities of foreign banks in the US. I suspect that the US Government has placed some form of pressure on them to purchase subprime collateralised debt obligations and other dodgy financial securities in the first instance (Just as the Bush administration did to local authorities in US states.) And we know that a high degree of fraud has been involved in selling such 'products'.

In the last several days there has been an emerging consensus among well-informed analysts (like this and this) regarding the Fed/Treasury plan to bail out financial markets. It goes something this: the US financial sector faces a liquidity crisis on top of a solvency crisis. The liquidity part is that financial intermediaries (only some of them banks) are increasingly unable to meet their obligations to depositors and counterparties because they have no access to credit. Highly leveraged, they do not have the resources at hand to carry on their business. If this were the entire problem, the Fed could solve it by offering to buy mortgage-backed securities and similar assets at their actual market value. In that case there would be no bailout, just an infusion of liquidity to tide the markets over.

But there is an underlying solvency crisis: as housing values have declined, assets tied to them are no longer worth the financial obligations institutions have incurred in acquiring them. A large portion of the financial system (no one knows at this point how large this is) has negative net worth. This is why Bernanke has spoken of purchasing assets at their face rather than market value.

There are two gigantic problems with the bailout scheme, in addition to all the smaller ones. First, overpaying banks, investment funds and other financial players to the tune of hundreds of billions of dollars is an ethical and moral hazard nightmare. These people have made obscene fortunes in wild speculation; now that their bets have gone sour is it the public’s duty to cover their losses? Second, it is not even clear that the strategy will work. We don’t know how much it will take to bring the financial sector back to life, partly due to the lack of transparency that helped get us into this mess in the first place, and also to the understandable reluctance of firms to mark down all the paper that has declined in value. It may well be that between one and two trillion dollars will be needed to get the markets back on their feet, and this may exceed the financial and political resources of the federal government.

A big improvement (championed by Paul Krugman) would a buyout of the firms rather than the assets, even as an option as formulated in the Dodd proposal. Still, and especially in light of the difficulty in disentangling viable portfolios from moribund ones, the cost may be too great. It would be nice to have something completely different on the table. So read on: here is a Plan B, an alternative to bailouts that might restore a functioning credit mechanism to the US economy.

The concept: The existing approach tries to bring existing institutions out of insolvency and credit gridlock. Plan B allows these institutions to go belly up but rapidly creates a parallel financial mechanism to rescue sound assets from the rubble while offering credit to new borrowers. Rather than providing a public prop, it provides a public alternative.

The plan: Create a new publicly-financed, publicly-run enterprise; for the purposes of this description we can call it Fund US. Its initial capitalization would be provided by a Treasury issue. The amount could well be much less than the $700B (or $1.4 trillion in borrowing authority) that headlines the existing plan. This is because the fund would be permitted to leverage up to some reasonable ceiling—say six-to-one. So give it $300B as an initial allocation.

One initial function of Fund US would be to open a window for the purchase of existing financial assets at fair market value. This is not necessarily the same as the value of the moment, since, by its size relative to the markets as a whole, Fund US would be a price-maker. One possibility would be to honor prices as of September 15, before any general public plan was broached. Another, specifically for MBS’s, would be to use an algorithm based on a decline of the Case-Schiller Index to long run trend. Either way, this would protect the genuine value of financial wealth tied to housing from the cascade of defaults likely to sweep through the private sector.

The other main function would be to serve as an all-purpose financial intermediary to the US economy and to foreign interests that do business here. It would underwrite existing loans or other contracts, originate new credit and assemble a portfolio of financial assets in a manner consistent with prudent management. On the liability side, it would accept deposits and sell instruments like mutual funds and secondary debt. In other words, it would do what the current system does, subject to greater constraint.

What could assure this constraint? Here are some ideas: (1) The limit on leverage would be statutory. (2) Full transparency could be written into the legislation authorizing Fund US. All assets and liabilities would be publicly reported and all terms made explicit. (Small borrowers and lenders could have their individual identities protected for privacy purposes.) (3) There could be systems of oversight and undersight. The first would be provided by an outside board of disinterested specialists, primarily academics in the fields of accounting and finance. For the second, we might have front-line employees, who analyze and perform individual transactions, constitute themselves into a review body. This entity could give frequent public assessments of the quality of the Fund’s activities and their adherence to overall policy objectives—institutionalized, routinized whistle-blowing capacity. (4) All employees of the Fund, top to bottom, should be paid fixed salaries—no commissions or bonuses. (5) The Fund’s goals should be to maintain the value of public equity, minimize aggregate risk and have the capacity to supply credit sufficient to meet the needs of the economy. Profit maximization, returns in excess of what is necessary to supply a net worth buffer, would not be a goal.

Of course, one paragraph cannot possible provide sufficient detail to demonstrate that such an institution is feasible. On the other hand, how many paragraphs do we have at this point for the mega-bailout?

Two additional elements of Plan B are required to complete this brief sketch. First, Fund US would not be a chartered monopoly. Any financial institutions that survive the ongoing shakeout can compete against it, as can startups. Indeed, because of its lack of incentive for aggressive marketing on both sides of the ledger, it may eventually evolve toward being a financial intermediary of last resort. This would be fine. Second, for competition in this market to be constructive, new regulation must be extended to all players along the lines currently being discussed. In particular, limits on leverage and transparency requirements should apply to all intermediaries, whatever their institutional morphology.

I will not make any great claims for Plan B. Its details require much more working out. There is also a valid concern that it may not be possible to get a massive new institution up and running before existing credit channels freeze up. It would have been much better to have developed a public fund slowly and carefully during the pre-crisis phase, but who was thinking this far ahead? I am less bothered by the ideological objection to a public institution taking on the functions of private firms and competing with them. To take one example, more than half of all the assets in the German banking system are in public and cooperative banks. Germany isn’t utopia (and one of its state banks was mauled because it indulged in dubious US assets), but it is, along with China, the world’s leading industrial exporter. It runs a huge trade surplus with the US, largely due to the strength of its small and medium-size enterprises. Small firms in Germany are global players because they have the same access to capital as big ones, something that can’t be said for the US. This is not to say that we should copy the German template, just that there is no reason to assume that public financial institutions can’t support a successful modern economy.

Plan B is offered to you as a stimulus to creative thinking about the current imbroglio. I would be interested to find out if it can withstand scrutiny.

In 1962 the founder of AIG gave control of the company's US holdings to Maurice R. "Hank" Greenberg. Greenberg then changed the focus of AIG from personal insurance to "high-margin corporate coverage" and, in 1987, he appointed Henry Kissinger as chairman of AIG’s International Advisory Board.

Maurice Greenberg's history is a very interesting one to follow. After all, he is a past Chairman, Deputy Chairman and Director of the Federal Reserve Bank of New York - an organisation that loaned money to AIG at AIG's request to prevent the company's collapse this month and on terms that were acceptable to the AIG board.

In 2005 AIG's board forced Greenberg to resign from his post as Chairman and CEO under following criticism from Eliot Spitzer, attorney general of New York State. Spitzer alleged fraudulent business practice, securities fraud, common law fraud, and other violations of insurance and securities laws. The charges were dropped later and civil action followed. The year before two AIG executives pleaded guilty to criminal charges in connection with their "illegal course of conduct" relating to 'payoff agreements' with (at least) one other corporation for steering clients to AIG and for soliciting rigged bids for insurance contracts.Other current positions of AIG's most influential man:- As current Chairman of the Starr Foundation Greenberg "oversees the disbursement of major financial support to academic, medical, cultural, and public policy institutions."- He is Honorary Vice Chairman and Director of the Council on Foreign Relations and a member of David Rockefeller's Trilateral Commission. - Current Chairman and Trustee of 3 institutions founded by the Rockefeller family. - A former Chairman and current member of the US–Korea Business Council, a member of the US–China Business Council, and the Business Council.

In the past he has served on the Board of Directors of the New York Stock Exchange, the President’s Advisory Committee for Trade Policy and Negotiations, and the Business Roundtable. (Former US President Reagan offered him a job as as Deputy Director of the CIA, which he declined.) in the years of 1998-2005 Greenberg was a member of Hong Kong Chief Executive's Council of International Advisers .

From Wikipedia today.http://en.wikipedia.org/wiki/Maurice_R._Greenberghttp://en.wikipedia.org/wiki/American_International_Group

Tuesday, September 23, 2008

[This is such an extraordinary week. So many economic writers are focussing on a very narrow range of financial crises. However, the structural problems that created this catastrophe need also to be addressed quickly.]

** The provision of essential goods and services has been left to ‘market’ demand.

Today’s news: Chesapeake Energy CEO Aubrey McClendon said Tuesday he would not be surprised if US drillers dropped hundreds of rigs in the next couple of quarters due to lower natural gas prices.[1]

** Inflation has been inappropriately treated as a monetary phenomenon with policy implementation resulting in world-wide recessions.

[Inflation] “became a problem which had to be treated, but by means other than those recommended by Dr Friedman and his colleagues. So they decided, because they thought it was a monetary phenomenon, which it wasn't, that the way to cure it was to crack down on the monetary system to tighten money and raise interest rates. And they had a little go at it in 1974-75, and they brought on a little recession, at least in our part of the world. And then in 1980-81, Paul Volker, who was at that time the Chairman of the Federal Reserve Board in Washington, and who had become a disciple of Dr Friedman, said, 'We will put this to the test'. And so he brought on a horrendous recession which was virtually world-wide…”[2]

** The functioning of critical domestic institutions is dependent on the inflow of foreign capital.

“…The fact is that Henry Paulson and this economic team and this failed administration in terms of economic policy, they have to say whatever they can about this money because without that foreign capital we have institution after institution that is simply insolvent.”[3]

** Finance capital is monopolized.

“No bank in the world will loan to a country blacklisted by the World Bank. To obtain funding from any bank, developing world governments must adjust their policies (called structural adjustments) to the dictates of the IMF/World Bank/NAFTA/ GATT/WTO/MAI/GATS/FTAA/military colossus. It is specifically under the imposed structural adjustment rules of that colossus that protections for the fast developing nations were withdrawn. Not only is the developing world locked within the parameters of the decisions of international capital, if any developed world government veers from the prescribed path, enough capital will flee to turn the economy downward, the politicians (not the subtle finance monopolists) will be blamed and—to maintain themselves within the good graces of the voters—the politicians will bend to the wishes of capital, even if it is to the detriment of the nation of their birth or of the world.”[4]

Monday, September 22, 2008

And on a different note, here are my thoughts on possible recipients for this years Sveriges Bank Prize in Economic Science in Memory of Alfred Nobel. First, I hope that it does not go to either of two prominent macroeconomists who regularly get mentioned. This would be an extremely inappropriate year for such, given what is going on. However, here are five I could live with who I think are on the list, at least one of whom I do not think has been publicly mentioned, or at least not much.

William Baumol, for lots of thingsJagdish Bhagwati with Avinash Dixit, for international trade theoryGordon Tullock with Anne Krueger, for rent seekingBenoit Mandelbrot, possibly with Eugene Fama, just to freak everybody out, although Mandelbrot is the more deserving in my view (for complexity) but certainly for recognizing the reality of fat tails in financial markets, now more evident than ever (if they give it Fama and not Mandelbrot, that would be a ridiculous farce).Richard Easterlin, for happiness. He is the man on that one, and deserving. Of this group, it is him and Mandelbrot whom I would most like to see.

BTW, to Brenda, there ought to be one for ecological economics, but I doubt this is the year, and I am not sure who should get it.

In today's WaPo, Ruth Marcus tries to put herself back into "journalistic symmetry" after having sharply criticizing McCain for his fallacious ads last week by misrepresenting Obama's and McCain's (and more importantly, Bush's) positions on Social Security. She declares that Obama is lying to old people in Miami that privatizing Social Security, which McCain has supported as recently as this Sunday will hurt their pensions, citing the never-quite-fully-explicated "plan" that Bush put forward in 2005 and that McCain supported.

Now, it is true that that plan claimed it would not cut current benefits of current retirees. However, it would start removing revenues from the system to go into the private accounts of young people, with about a six-year window of people in their 40s being targeted to get neither private accounts, but definite cuts in their benefits. There are two problems here.

One is that even though there would be no immediate cuts in benefits, taking away revenues would weaken the system and increase the likelihood of cuts being imposed in the future, quite possibly on people currently receiving benefits. The second is the ongoing hypocrisy of declaring that the future economy is bleak and that therefore the future of social security revenues is bleak, even as in a majority of years in the past decade the revenues did better than the "low cost projection" that has the system never running a deficit, much less going "bankrupt," while on the other hand the stock market is supposed to perform wonders so as to provide these fabulous returns on private accounts.

In any case, Marcus is simply off base in going after Obama. Privatizing Social Security does threaten the system by reducing its revenues, thereby increasing the dangers for current recipients down the road, and his formulation in Miami was about what would have been the case if those seniors did have their Social Security in private accounts, which is accurate.

I am about to go out of town for nearly two weeks (including to a conference in my honor in Urbino, Italy), and so will probably disappear from here mostly for awhile. So, will do three posts in a row.

This one is a confession of ignorance and inability to speak by a usual loudmouth. I am one of those like Dean Baker and Robert Shiller who has been calling loudly for a long time that we were in a housing bubble and that this would lead to bad trouble. More recently here I pointed out that we were probably in a period of financial distress, with a much worse panic and crash likely to be coming. As of last Wednesday, when US Treasuries briefly were in negative interest rate territory, we were as close to 1931 as we have been since, well, 1931. Unfortunately, we may yet get a lot closer.

Everybody else seems to have well-formed opinions about the Paulson bailout and what we should or should not do. I do not. The plan has all kinds of problems, money for the undeserving rich, too much power for Paulson and later TreasSecs, not enough protection for homeowners, unclear defense of the global financial markets, not enough protection of US taxpayers, and on and on, see lots of commentators everywhere. Unfortunately, if nothing is done, well, could be into a situation making last Wednesday look like child's play. What is even worse is that even doing it (after all, we have had scads of "saves" during the past year) may not work and could still lead to something worse than 1931. After all, after this bailout, I think that Bernanke and Paulson and Geithner and company will have pretty much used up all their arrows or magic rabbits in hats, or whatever. If it (or whatever variation on it might come out of Congress) does not work, we may really be up that famous creek without a you know what. And, I do not know what to do.

1990 - "An economic crisis of colossal proportions". The US Government would become one of the main owners of real estate, buildings, and the worthless junk bonds.

"...the gathering collapse of the real estate market after the stock market crash of October, 1987. The sequence of a stock market panic followed by a real estate and banking crisis closely followed the sequence of the Great Depression of the 1930's....[the] federal government would simply take control of the savings banks, the overwhelming majority of which were bankrupt or imminently bankrupt. ...[Bush Sr] proposed to issue an additional $50 billion in new bonds through a financing corporation, a subsidiary of the new Resolution Trust Corporation...." [1]

After all, it isn't as if these strategies actually resulted in a resolution.

1994 US interest rates rose rapidly and that triggering massive losses in highlyleveraged derivative positions held by 'investors'. That same year the Mexican market collapsed, triggering a significant emerging market liquidity crisis. Then in 1997 the collapse of Asian equity and currency markets followed by corporate collapses and falls in asset prices. A major bad debt crisis is then created within financial institutions.

Then onto the 1998 Russian default on its debt leading to an emerging marketcollapse. This also linked to the collapse of LTCM which is bailed out by a group of banks under US Federal Reserve auspices. Market and trading liquidity deteriorates, credit spreads also increase rapidly. The next year central banks announce a reduction in planned gold sales and gold lending programs. Losses for gold hedgers are experienced. Those that have large forward sales programs.

Forward, to the 21st Century with the bankruptcy of Enron and Worldcom and the Argentina default. General Motors and Ford are downgraded to “junk” status in 2005 -->hedge fund crisis. An emerging market correction in 2006; following on its heels, the subprime mortgage crisis of 2007.

Governments that thieve from the public purse to pay banks and hedge funds can always depend on the support of banks and hedge funds. (They're the ones that have financed the two presidential candidates in the upcoming US election, after all).

Sunday, September 21, 2008

How about instead of giving a couple trillion dollars to the financial institutions, instituting a financial holiday -- something like FDR created -- and use the trillions of dollars to create infrastructure and affordable housing?We could also raise some more money by ending the wars and cutting back military spending.

Some of the money would be left over to create national health care, alternative energy, and tuition support.

If we needed more money beyond that, we could raise taxes. With all the spying on ordinary people, the NSA must certainly know where the fat cats are hiding their money in tax shelters.

Sure, there would be problems. People would need access to their money to get groceries and the like before the jobs were online. But the plan suggested here seems no more outrageous than rewarding the felons for their crimes.

Something patched together by the Treasury this quickly is sure to do more damage than any outrageous suggestions made above.

Peter S. Goodman offers a revealing summary in this morning's New York Times of the magical thinking behind the Bernanke/Paulson BIG BAILOUT. A $700 Billion Rescue Plan for Wall St., but Will It Work? After the jump Sandwichman elaborates on what is magical about this thinking, if it isn't obvious from the quote.

If the plan works, it will attack the central cause of American economic distress: the continued plunge in housing prices. If banks resumed lending more liberally, mortgages would become more readily available. That would give more people the wherewithal to buy homes, lifting housing prices or at least preventing them from falling further. This would prevent more mortgage-linked investments from going bad, further easing the strain on banks. As a result, the current downward spiral would end and start heading up.

First, the "central cause of American economic distress" is not the plunge in housing prices. That is merely a symptom and, moreover, only the latest phase in a symptomatic process. The real cause of distress, to state it simply, is the growing disparity between wages and living costs. Rising house prices temporarily enabled consumers to borry money to patch over the gap between the cost of living and wages. And easy credit kept house prices going up. The jig is up on that game.

Second, trust is a two-way street. Just because the banks resume lending doesn't mean consumers will resume borrowing and spending. If we think of the current crisis in the credit-markets as a lender's strike what is likely to come next is a borrower's reluctance. The inflationary buy-now mentality has been stomped out by the market panic. In its place will be an anxious wait-and-see caution by consumers. Sadder but wiser. Presumably that caution will be reinforced by a tighter regulatory regime that discourages concealed-risk lending.

Fixing the credit crisis will not do anything about the gap betweeen wages and the cost of living. If anything, the cost of living will continue to rise in the U.S. because of a shrinking dollar. The trillion-dollar bailout is at root a trillion-dollar devalution. Real wages will continue to fall because the threat of unemployment will impede wage demands.

Ending "the current downward spiral" of house prices doesn't ensure a rebound. There may indeed be a dead-cat bounce after which the economic decline will resume at a more stately pace. What is just around the corner is not a restoration of the pre-collapse boom but a lingering malaise.

The Way Forward: No Free Lunch, No Quick Fix

The Bernanke/Paulson BIG BAILOUT is a shot across the bow of a sinking ship. It is presented by the same folks who brought us the debacle. If it succeeds in stabilizing markets for the time being -- which is by no means certain -- that in itself will be somewhat of a relief. But it won't be a solution. There is no easy solution. The damage done to the financial system was done by the financial system. Recovery requires not restoring that financial system but replacing it.

Did I say something about wages and the cost of living? How can the two be reconciled? It can't be done by legislating price controls or wage increases. That could only change nominal prices or nominal wages. What counts are real prices and real wages. The regulatory tool for bringing about REAL wage increases is, paradoxically enough, reducing the standard hours of work. In the 1870s, Mary Steward wrote this little ditty, "Whether you work by the piece or work by the day, decreasing the hours increases the pay."

It sounds almost magical. Too good to be true. Shorter hours and higher pay. Happy days are here again! But... does it sound any more magical than the Bernanke/Paulson rescue refrain: easier credit and higher house prices?

People hate paradox. It is important to point out that the paradox of shorter hours and higher wages is only apparent. The seeming paradox is an artifact of a frame of thought that sees no contradiction in the notion that debt is the source and foundation of prosperity. A lot of things are also hard to explain if you insist on the unshakeable principle that the sun revolves around the earth.

A sub-head in today's NYT proclaimed, "A Professor and a Trader Bury Old Dogma." Not so fast. Replacing the free market dogma with the government intervention dogma leaves intact the conviction that prosperity is founded on debt, "since," as the Globe and Mail put it yesterday, "US growth has always been fuelled by easy access to debt." Meet the new dogma. Same as the old dogma. Get on your knees and pray we don't get fooled again.

Or, forget about that new dogma and consider this old doggeral instead: "Whether you work by the piece or work by the day, decreasing the hours increases the pay." Put your mind in a different frame. Digest the profoundly radical reasoning underlying that superficial rhyme.

Fragments of a New Synthesis

The Sandwichman apologizes profusely for not completing his new synthesis in time for the financial collapse and bailout. Actually, the Sandwichman wonders if he is up to the task, which entails distilling a weird mixture of scholarship and ballyhoo into a simple but authoritative, sensible, step-by-step treatise. But here are the elements of that treatise: an anoymous 1821 pamphlet, "The Source and Remedy of the National Difficulties: Deduced from Principles of Political Economy, in a Letter to Lord John Russell," "The Economic and Social Importance of the Eight-Hour Movement," by George Gunton and "Hours of Labour," by Sydney J. Chapman.

For those readers interested in connecting the dots themselves or impatient waiting for the Sandwichman to figure out how to do it, here are some links to elements of the work in process dealing with Chapman, Gunton and the Source and Remedy. I will post links to the original documents as soon as I can get around to formatting and uploading them.

The biggest lacuna so far is with regard to George Gunton and his treatment of Ira Steward's eight-hour theory. In part this is due to leaps in Gunton's own analysis and the need to address the resulting gaps by reference to, for example, Chapman's theory, which itself is incomplete... but in different ways.

** The finance and banking industry is dependent on CHEAP oil. We’re now at peak oil.

"The flow rates from the existing projects are the key. Capacity coming on stream falls fast beyond 2011. On top of that, if the big old fields begin collapsing, the descent in supply will hit the world very hard."[1]

``We can call it an `oil crisis' given the current price, and that it continues to climb even after global efforts to cut consumption.'' ``We see a critical, structural issue in the global oil market, where supply growth isn't catching up with demand.''[2]

** Today’s collapsing financial markets originate with the following: (i) the emergence of the large, modern global corporation; (ii) the concentration of economic and political power encompassed within these TNCs along with their extraordinary (iii) labour-free productive capacities. These developments were intimately linked with the (iv) energy crisis of the 1970s and (v) the continuing and steadily-worsening inequalities in global incomes.

This also marks the recycling of petroleum dollars through the Euromarket and heavy lending to the largest Latin American countries, leading to the debt crisis of the early 1980s. The post-war ‘golden period’ came to a close in the mid 1970s when global productive capacity outran global demand. Inflation also affected the Northen economies, and there was a crisis of import substitution industrialisation in the South.

"corporations that neither have bodies to kick nor souls to damn" Andrew Jackson

** The global financial system is high volume and high velocity. The many coordinated components, are linked rather than regulated. If new measures are made in the context of no other changes, the outcome is likely to be explosive. [Naked Capitalism's interesting post this week.]

** The export of inflation to the rest of the world.

When the US dollar plunged in value due to the US Fed’s easy-money policy the central banks in emerging economies could not tighten monetary policy because it would have led to an appreciation of their currencies as compared to the US dollar. The US Fed thus, defacto, exported rising inflation to these nations. Also consider the Bank of Japan’s low interest rate policy and the rise in the real global cost of oil. This rise occurs when the US dollar deflates due to this currency's monopoly in global oil trades [3]. The globalisation of trade flows is another new transmission mechanism of worldwide inflation. World exports should reach a record of 32.5% of global gross domestic product in 2008, according to the IMF.

** Divergence between the expansive financial global economic crisis, exported economy and the stagnant real economy. This is not accidental.

For example, the Bush Administration "embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from [predatory subprime lending]." [4]

Uncontrolled financial gyrations are an expression of this imbalance.This ‘disconnect’ stems from stagnationist trends in the real economy such as overcapacity, overproduction. The search for profits is the driving force of capitalism. It evolved in such as way so that profits could only be obtained from financial speculation rather than investment in industry.

** Technology makes it far easier to police an American citizen than an international bank.

** A disconnect between the assessors of risk from those that actually bear the risk

CONTINUED --->

** Fabricated demand for subprime mortgages

“..The subprime mortgage crisis was not a case of supply outrunning real demand. The "demand" was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that flooded the US in the last decade…” [5]

** Securitisation

The securitization of standard mortgages was a technique by which Savings and Loans and Mortgage companies originated mortgages which were then packaged as securities for the portfolios of holders such as pension funds, life insurance companies, mutual trusts and various international holders. Because of the way the mortgages were packaged it was possible to sell off a package of mortgages at a premium so that the originator and the investment banking firms walked away from the deal with a net income and no recourse from the holders. The instrument originators and the security underwriters did not hazard any of their wealth on the longer term viability of the underlying projects. Obviously in such packaged financing the selection and supervisory functions of lenders and underwriters are not as well done as they might be when the fortunes of the originators are at hazard over the longer term. All that was required for the originators to earn their stipend was skill avoiding obvious fraud and in structuring the package. Hyman Minsky,1992

** The lifting of controls over capital

The housing bubble is but the latest of some 100 financial crises that have swiftly followed one another ever since Depression-era capital controls began being lifted at the onset of the neoliberal [financialisation] era in the early 1980's. [5] Speculative capital then became globalised to take advantage of differentials in foreign exchange and interest rates in disparate capital markets.

[4] Predatory Lenders' Partner in Crime - How the Bush Administration Stopped the States From Stepping In to Help Consumers. By Eliot Spitzer (Governor of New York)Thursday, February 14, 2008; Page A25http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html

[5] Capitalism in an apocalyptic mood. Walden Bello. Focus on the Global South, 20 February 2008http://www.tni.org/detail_page.phtml?&act_id=17956

Saturday, September 20, 2008

Say economic growth after the BIG BAILOUT is slow for several years (a modest proposition). Inevitably the unemployment rate will mount. People may attribute the increased unemployment to the aftermath of the financial crisis. Post hoc ergo propter hoc. But, rather than being the CAUSE of unemployment, it would be more accurate to view the financial distress as simply the withdrawal of a palliative.

Economic orthodoxy insists that "technology creates more jobs than it destroys" -- a view that by the end of 1932 even Fortune magazine dismissed as unsatisfactory. In an article titled "Obsolete Men", the Fortune editors recalled the mechanistic explanation that the reduced cost from the use of labor-saving devices led to lower prices, increased demand and new employment to meet the greater demand. Where demand for any particular good was inelastic, workers displaced from one industry would find employment elsewhere.

Fortune concluded that it was accelerated economic growth, not lower market prices, that counteracted the job-killing potential of labor-saving technology. But, as an article in today's Globe and Mail puts it, "... U.S. growth has always been fueled by easy access to debt."

I thought the believers in the market accepted the logic of shock therapy. You know, when country stray too far from market fundamentals they need tough medicine to make their economy strong.

Consider the case of Jeffrey Sachs writing in his recent book, The End of Poverty. Looking back on his first prescription of shock therapy in the destitute nation of Bolivia Sachs had a revelation. He realized that "Bolivia's physical geography was a fundamental feature of its economic situation, not merely an incidental fact .... Of course I knew that Bolivia was landlocked and mountainous .... Yet I had not reflected on how these conditions were key geographical factors, perhaps the overriding factors, in Bolivia's chronic poverty .... Almost all the international commentary and academic economic writing about Bolivia neglected this very basic point. It bothered me greatly that the most basic and central features of economic reality could be overlooked by academic economists spinning their theories from thousands of miles away." Yet, he concluded: "Monetary theory, thank goodness, still worked at thirteen thousand feet."

Sachs, Jeffrey D. 2005. The End of Poverty (London: Penguin): p. 105.

Jeffrey Sachs is relatively liberal, as far as economists go. After all, economists today confidently tell us that Keynes is dead. Everyone has to accept the discipline of the market: the unemployed, people without medical insurance, and students facing high tuition. If workers wages fall short, they are at fault for lacking the skills of a financial manager.

But wait! Now that the financial managers are in trouble, boy do they need help.

I only have one question for market fundamentalists. If these bailouts succeed in putting Humpty Dumpty together again, will our fundamentalists agree to tax the fat cats or will they revise history and tell us that their rebuilt wealth owes everything to their hard work and intelligence?

Or, what I'm afraid is more likely, is that market fundamentalism is applicable only in impoverished countries 13,000 feet above sea level.

Justin Rood debunks the latest lie from McCain-Palin on Troopergate. The McCain-Palin latest excuse for the firing of Walt Monegan:

Fighting back against allegations she may have fired her then-Public Safety Commissioner, Walt Monegan, for refusing to go along with a personal vendetta, Palin on Monday argued in a legal filing that she fired Monegan because he had a "rogue mentality" and was bucking her administration's directives. "The last straw," her lawyer argued, came when he planned a trip to Washington, D.C., to seek federal funds for an aggressive anti-sexual-violence program. The project, expected to cost from $10 million to $20 million a year for five years, would have been the first of its kind in Alaska, which leads the nation in reported forcible rape. The McCain-Palin campaign echoed the charge in a press release it distributed Monday, concurrent with Palin's legal filing. "Mr. Monegan persisted in planning to make the unauthorized lobbying trip to D.C.," the release stated.

Let’s say we buy this story. This means that the Public Safety Commissioner was pushing for funding of something very important – government efforts to reduce the high rate of rape in his state. One would have thought the governor would be all for this but McCain-Palin now want us to believe that these efforts from Monegan were discouraged by the governor to the point that she fired him. Thank goodness this is not true:

But the governor's staff authorized the trip, according to an internal travel document from the Department of Public Safety, released Friday in response to an open records request. The document, a state travel authorization form, shows that Palin's chief of staff, Mike Nizich, approved Monegan's trip to Washington, D.C., "to attend meeting with Senator Murkowski." The date next to Nizich's signature reads June 18.

So maybe the governor was not so indifferent towards the high rate of rape in Alaska. But then why did she fire Monegan? The story continues:

In response to inquiries about the document Friday, the McCain-Palin campaign provided a statement from Randy Ruaro, another aide to Palin. According to Ruaro, Monegan asked for -- and received -- approval for the travel without telling Palin's staff his reason for going. "As a matter of routine, the travel was approved by Mike Nizich ... weeks before the actual purpose was made clear by former Commissioner Monegan," Ruaro wrote. "When you receive permission to travel, it does not mean that you receive blanket authorization to discuss or do whatever you would like on that trip," he added.

In other words, the governor did not want the Public Safety Commissioner discussing means to reduce rape in Alaska with Senator Murkowski? I’m really confused.

Friday, September 19, 2008

Perelman has previously mentioned his forthcoming book on the irrelevance of workers in economic theory. Yesterday, I received a note from David Spencer about his forthcoming book, The Political Economy of Work, which is due out in about a week. Everybody knows that the BIG BAILOUT heralds "the most radical regime change in global economic and financial affairs in decades." But what has it all got to do with work and workers? Higher unemployment? Increasing cost of living? Quite possibly those things -- but another as yet unspoken dimension of the collapse-and-bailout of the financial system and its impending re-regulation is that it authorizes a re-opening of debate about the regulation of labor markets.

Until recently, the official Anglo-American journalistic line on labor market regulation was that it was bad. Europeans had to liberalize their labor markets or risk falling further and further behind the dynamic US economy. Well, now we know -- as some of us have been pointing out all along -- that the dynamism was contrived. It is time to re-assess ALL the hoary myths about the inherent superiority of "free markets", including that one.

the Federal Reserve should get back to its core business of responsibly managing our money supply and inflation. It needs to get out of the business of bailouts. The Fed needs to return to protecting the purchasing power of the dollar. A strong dollar will reduce energy and food prices. It will stimulate sustainable economic growth and get this economy moving again.

The second sentence basically advocates that the government should allow the current financial crisis to worsen. On this one, Brad DeLong needs the microphone:

Since before 1844 central banks have been in the business of managing financial crises. That's what they do. Milton Friedman is spinning in his grave. The prevention of large-scale bank failures--"bailouts," in McCain's terms--is an essential part of responsibly managing the money supply. John McCain does not know that. And nobody working for John McCain knows that

The call for a strong dollar is a call for higher interest rates and dollar appreciation. How will discouraging investment and reducing net exports lead to an increase in aggregate demand is beyond me. I’d like one of McCain’s economic advisors to explain that!

Our nominal head of state has been invisible during this latest flare-up of the financial crisis. Of course, we would expect Bernanke and Paulson to be the public face of the administration’s crisis management plans, but in theory they (especially Paulson) do have a boss. We’re talking here about the largest, most consequential domestic program in the entire GWB era. I mean, who’s the decider here?

If congressional Republicans balk at the size and cost of the bailout, will Bush have to come out of confinement to talk them into it?

According to today’s New York Times, it’s the beleaguered US taxpayer. In fact, the word “taxpayer” appears five times in their report on Fed/Treasury actions, always in connection with where the burden will fall. But this is flatly wrong.

In case my previous post was too oblique, let me say it bluntly: Taxpayers are not and will not be the ones to finance the bailout of the financial sector. There will be no tax increase to pay for it, nor will there be drastic (eleven-figure) cuts in other federal spending. It will be financed by substantially greater public borrowing from sovereign creditors, especially the People’s Bank of China and the various entities of the Gulf Cooperation Council. (Russia is an uncertainty in light of its own financial crisis.) The feasibility of the bailout depends entirely on the continued willingness of these deeply authoritarian countries to continue recycling their mountainous piles of dollars into dollar-denominated assets—formerly including private sector debt but now public debt exclusively.

In the absence of this external support, no bailout plan is remotely possible.

I mentioned earlier that I thought that looking at production and distribution of income was crucial to understanding the financial crisis. Of course, the financial side provided the tipping point.

Some thing similar happened a few decades ago with a war, a different Bush, and John McCain.

Many years ago, Lyndon Johnson, who would have just celebrated his hundredth birthday couple days ago, found himself stuck in a war he couldn't win. He also knew that if he raised taxes to pay for the war, the public would demand an immediate halt with an intensity that he could not resist. Johnson relied on borrowing, which raised interest rates.

Savings and loan institutions, like the investment banks today, borrowed short and lent long. In this case, people put their savings in the banks and the banks lent out money on 30 year mortgages. To prevent gouging and make mortgages affordable, the Savings and Loans were prevented from paying interest rates high enough to keep depositors from exiting, which could make them bankrupt.

The Reagan administration, including daddy Bush, moved to deregulate the Savings and Loans. Given this newfound freedom, crooks and nincompoops (including President Bush's younger brother) rushed in to take advantage of profiting from other people's money. As the scope of this disaster was becoming obvious, five senators, including John McCain along with Alan Greenspan (perhaps the Godfather of the recent financial crisis), rushed in to defend one of the more egregious Savings and Loan operations run by Charles Keating. Oh, yes, a small savings-and-loan in Arkansas, which was connected with Bill Clinton (who allowed Congress to deregulate the current financial system, led by Senator Phil Gramm, John McCain's chief economic adviser) also ran into difficulties.

The savings-and-loan scam crashed leaving the government to pick up the pieces at a cost that is still debated, but which was still well over $100 billion -- pocket change today.

The difference today is that our politicians will really do excellent regulation this time, just as they did with Sarbanes-Oxley in the wake of Enron.

Glenn Hubbard calls for smarter regulations to address the current financial crisis. While it hard to disagree with his plea, this offends me:

Now, consider the candidates' economic philosophies. John McCain champions openness, low taxes and efficient regulation. Barack Obama is more skeptical of gains from trade and global finance, and he favors tax increases on capital and a variety of regulatory solutions. In this environment, these differences are revealing (and the advantage goes to McCain).

Glenn’s praise of McCain is simply wrong. McCain used to champion the removal of regulations but now he has flipped-flopped into an uber-regulator who abhors short selling and thinks the head of the SEC should be fired. I seriously doubt Glenn thinks such inconsistencies from our policy makers is a good idea. I’ll leave it to the economists advising Obama as to Glenn’s claim that they don’t believe in the gains from trade.

A question I sometimes ask my intro macro students is, could the Fed, if it wished, conduct open market operations by buying (and later perhaps selling) famous paintings, rock memorabilia, etc.? This tests their understanding of the concept: any asset can be used to inject or absorb liquidity. Little did I suspect that the asset in question might be vast swaths of suburban tract housing. But the recent announcement that the Fed’s acquisition of junk mortgages would be partly financed by $100B in new Treasury issues indicates that the bailout is being insulated as far as possible from monetary policy.

But this is interesting from the standpoint of global capital flows too. Many of the investments of the last few years, like Chinese purchases of Fannie and Freddie stuff and Gulf capitalizations of US banks and shadow banks, aren’t looking very good right now. All indications, in fact, are that sovereign funds are rebalancing as fast as they can away from anything that bears the slightest whiff of the US housing market. But where can they go and still stay in dollars? Answer: the Fed can buy up the tainted assets our creditors no longer want to hold, financed by new Treasury bonds, financed by these same creditors. The creditors are happy (or at least placated) by being able to shift away from risk, the capital inflows needed to finance the US external deficit keep flowing, and enough domestic credit market players are refloated to keep the debt game going a while longer. In theory the Fed/Treasury risk laundering scheme could be extended to new classes of debt, like consumer credit and corporate paper, as their quality deteriorates. The longer it continues, the longer US employment and income can be buoyed up by borrowing, giving the macroeconomy a semblance of stability. I’m getting the feeling, however, that this is an endgame scenario, not a new financial equilibrium.

Thursday, September 18, 2008

Over at Angry Bear, that great defender of Social Security, Bruce Webb, has declared that he is taking a vacation until next spring because Social Security is safe for now? Is he right? The obvious answer would seem to be "yes," with the most recent financial crises seriously undermining the argument for privatization that Republicans have pushed so relentlessly, including both President Bush and candidate John McCain, whose plan has not been well defined, anymore than was Bush's was back in 2005, when he made his big failed push.

Of course, this leaves the question of what Obama might do, with a Dem more in the position to actually do something to Social Security. I used to worry that Hillary would get in and follow her husband's former desire to "reform" SS. However, it seems that Obama's position has improved. I, like Bruce Webb, am a hardliner that nothing needs to be done, disagreeing even with Dean Baker, who says nothing needs to be done, but who buys into CBO projections that say the system will be "bankrupt" in the late 2040s. Bruce and I are skeptical. Obama has proposed putting a fica tax on wage earners above $250,000 per year income, but more recently has said this should be done only "if necessary," thus putting it off. This is an improvement.

Actually, at this point, I agree with Paul Begala. Given the financial crises and McCain's incoherent pro-privatization position, I think Obama should use the issue and hit hard on McCain over it. Heck, time to play for Florida for real.

Bureaucratic regulation is very difficult. Even when the government sets up regulations, financial corporations manage to circumvent them without much more oversight than domesticate politicians are willing to provide.

In contrast, enormous resources are used to micromanage people without much power. This type of regulation is strangling education. Instead of single payer, ridiculous regulations of medicine are costing lives. Here is valuable testimony from a doctor writing in the new York Times.

"Not long ago, a colleague asked me for help in treating a patient with congestive heart failure who had just been transferred from another hospital. When I looked over the medical chart, I noticed that the patient, in his early 60s, was receiving an intravenous antibiotic every day. No one seemed to know why. Apparently it had been started in the emergency room at the other hospital because doctors there thought he might have pneumonia. But he did not appear to have pneumonia or any other infection. He had no fever. His white blood cell count was normal, and he wasn't coughing up sputum. His chest X-ray did show a vague marking, but that was probably just fluid in the lungs from heart failure."

"I ordered the antibiotic stopped - but not in time to prevent the patient from developing a severe diarrheal infection called C. difficile colitis, often caused by antibiotics. He became dehydrated. His temperature spiked to alarming levels. His white blood cell count almost tripled. In the end, with different antibiotics, the infection was brought under control, but not before the patient had spent almost two weeks in the hospital."

"The case illustrates a problem all too common in hospitals today: patients receiving antibiotics without solid evidence of an infection. And part of the blame lies with a program meant to improve patient care. The program is called pay for performance, P4P for short. Employers and insurers, including Medicare, have started about 100 such initiatives across the country. The general intent is to reward doctors for providing better care. For example, doctors receive bonuses if they prescribe ACE inhibitor drugs to patients with congestive heart failure. Hospitals get bonuses if they administer antibiotics to pneumonia patients in a timely manner."

"On the surface, this seems like a good idea: reward doctors and hospitals for quality, not just quantity. But even as it gains momentum, the initiative may be having untoward consequences. To get an inkling of the potential problems, one simply has to look at another quality-improvement program: surgical report cards. In the early 1990s, report cards were issued on surgeons performing coronary bypasses. The idea was to improve the quality of cardiac surgery by pointing out deficiencies in hospitals and surgeons; those who did not measure up would be forced to improve. But studies showed a very different result. A 2003 report by researchers at Northwestern and Stanford demonstrated there was a significant amount of "cherry-picking" of patients in states with mandatory report cards. In a survey in New York State, 63 percent of cardiac surgeons acknowledged that because of report cards, they were accepting only relatively healthy patients for heart bypass surgery. Fifty-nine percent of cardiologists said it had become harder to find a surgeon to operate on their most severely ill patients."

"Whenever you try to legislate professional behavior, there are bound to be unintended consequences. With surgical report cards, surgeons' numbers improved not only because of better performance but also because dying patients were not getting the operations they needed. Pay for performance is likely to have similar repercussions. Consider the requirement from Medicare that antibiotics be administered to a pneumonia patient within six hours of arriving at the hospital. The trouble is that doctors often cannot diagnose pneumonia that quickly. You have to talk to and examine a patient and wait for blood tests, chest X-rays and so on."

"Under P4P, there is pressure to treat even when the diagnosis isn't firm, as was the case with my patient with heart failure. So more and more antibiotics are being used in emergency rooms today, despite all-too-evident dangers like antibiotic-resistant bacteria and antibiotic-associated infections. I recently spoke with Dr. Charles Stimler, a senior health care quality consultant, about this problem. "We're in a difficult situation," he said. "We're introducing these things without thinking, without looking at the consequences. Doctors who wrote care guidelines never expected them to become performance measures." And the guidelines could have a chilling effect. "What about hospitals that stray from the guidelines in an effort to do even better?" Dr. Stimler asked.

"Should they be punished for trying to innovate? Will they have to take a hit financially until performance measures catch up with current research"?"

"The incentives for physicians raise problems too. Doctors are now being encouraged to voluntarily report to Medicare on 16 quality indicators, including prescribing aspirin and beta blocker drugs to patients who have suffered heart attacks and strict cholesterol and blood pressure control for diabetics. Those who perform well receive cash bonuses. But what to do about complex patients with multiple medical problems? Forty-eight percent of Medicare beneficiaries over 65 have at least three chronic conditions. Twenty-one percent have five or more. P4P quality measures are focused on acute illness. It isn't at all clear that they should be applied to elderly patients with multiple disorders who may have trouble keeping track of their medications."

"With P4P doling out bonuses, many doctors have expressed concern that they will feel pressured to prescribe "mandated" drugs, even to elderly patients who may not benefit, and to cherry-pick patients who can comply with pay-for-performance measures. And which doctor should be held responsible for meeting the quality guidelines? On average, Medicare patients see two primary-care physicians in any given year, and five specialists working in four practices. Care is widely dispersed, so it is difficult to assign responsibility to one doctor. If a doctor assumes responsibility for only a minority of her patients, then there is little financial incentive to participate in P4P. If she assumes too much responsibility, she may be unfairly blamed for any lapses in quality."

"Nor is it clear that pay for performance will actually result in better care, because it may end up benefiting mainly those physicians who already meet the guidelines. If they can collect bonuses by maintaining the status quo, what is the incentive to improve? Doctors have seldom been rewarded for excellence, at least not in any tangible way. In medical school, there were tests, board exams and lab practicals, but once you go into clinical practice, these traditional measures fall away. At first glance, pay for performance would seem to remedy this problem. But first its deep flaws must be addressed before patient care is compromised in unexpected ways."

Jauhar, Sandeep. 2008. "The Pitfalls of Linking Doctors' Pay to Performance." New York Times (8 September).

Arthur Samish was a lobbyist who ran California in the 40s and 50s. Senator Estes Kefauver described him: "He is a combination of Falstaff, Little Boy Blue and Machiavelli, crossed with an eel."

Samish recalled in his autobiography:

"One time a reporter asked me how I was getting along with the governor. "I am the governor of the legislature," I told him. "To hell with the governor of California."

His most important client was the sellers of alcoholic beverages. Samish had a keen understanding of the way that economy works. Here is his economic analysis:

"I operated on the theory that only by regulation and enforcement could the alcoholic beverage business thrive and prosper. Cutthroat competition could have been ruinous .... only by regulation and enforcement could the alcoholic beverage business thrive and prosper. Cutthroat competition could have been ruinous. So I put through fair-trade laws to protect wholesalers, distributors and retailers. All of them make a profit in California, and they always have."

"But look what happens in states that don't have fair trade. New York, for instance. When the fair-trade laws were in effect there, a liquor license could have been worth $250,000. Then the state removed fair trade and the license is worth virtually nothing. The liquor business started competing so fiercely that it was tough for anyone to make a profit."

See Samish, Arthur H. and Bob Thomas. 1971. The Secret Boss of California: The Life and High Times of Art Samish (New York: Crown).

Reports out of Minneapolis, combined with memories of New York during the 2004 Republican convention, make it clear that police across the country are adopting a new tactic to suppress demonstrations: they conduct mass arrests of as many demonstrators as they can, remove them from the action, then drop the charges. No doubt they are acting on studies that show that this is a cost-effective way of limiting protest activity, but it is also a clear violation of civil rights. A quick and dirty economic analysis suggests a possible solution.

False arrest has always been a problem, but an important countervailing factor has been the sheer cost of imprisonment and trial. The individual cop does not bear this cost, but the political jurisdiction does, and this gives them at least some incentive to reign in the most egregious miscreants on the police force. It would be far too optimistic to say that this incentive is strong enough to enforce a respect for civil liberties all on its own, but it probably leads to less infringement than we would otherwise have. The great Wobbly free speech fights of the pre-WWI era, in which an army of activists would descend on a town in order to get themselves arrested for the horrible crime of speaking freely in public places, were based on this cost. A town would find that granting freedom of speech, compared to the cost of confining and trying dozens or hundreds of IWW activists, was the “lesser evil”.

No such incentive operates against the tactic of mass arrest, followed by dismissal of charges. For the hundreds, including several journalists, herded onto a bridge in Minneapolis by riot police, handcuffed, led away, held and then released (too late for them to participate in the planned demonstration timed to coincide with McCain’s acceptance speech), the only incremental cost to the city was the plastic hand-ties. Next time they could go green and make them out of potato starch so they can be composted.

The point is that there needs to be a real cost. And in human terms, of course, there is a cost, the inconvenience and denial of rights experienced by those who are rounded up. Hence my proposal: those who care about this issue should promote a policy of financial compensation for any citizen who is arrested and then released without charges being filed. It is government’s way of saying, sorry for hassle—we made a mistake and will reimburse you for it. Suppose the amount were $100. This would have an insignificant effect on local budgets as long as the false arrests were occasional, honest mistakes. But if the police deliberately detain 500 citizens without cause they are exposing the taxpayers to an extra $50,000 payout. This might be enough to nip this tactic in the bud; if not there is always the possibility of giving the compensation an upward nudge.

This is an entirely feasible reform, as far as I can see. It has an obvious fairness value in situations where individuals are unfairly detained. And it would have minimal effect on local finances unless the tactic of mass false arrest is being contemplated.

Suppose somebody wants to make a bet with me that the San Francisco 49ers will win the next two Super Bowls. He gives me $100 today, and I have to give him $100 million in case he's right. The chances of this happening are very small, but just in case the impossible happens I want some backup. I buy insurance from my next-door neighbor. I offer to give him a nickel every week in return for his promise to cover my bet.

My neighbor sees that he has a good thing going -- getting money for nothing. After a while he takes on more and more bets until others follow in his footsteps. Soon, a market develops. In effect, people can bet on bets. Eventually, the total potential amount of money builds up into the billions and trillions of dollars.

Unexpectedly, the San Francisco 49ers win two Super Bowls in a row. My neighbor does not have $100 million on hand to cover my loss. The nickels I have been giving him have been wasted. I don't have $100 million either.

Suddenly everybody in the market is worried about people's ability to back up their bets. The Federal Reserve steps in and takes over the market. The free world is saved.

Tuesday, September 16, 2008

A couple of weeks ago - Feldstein and Taylor claimed that McCain’s fiscal policy proposals would increase national savings and investment. Brad DeLong has finally read their WSJ op-ed and finds it really embarrassing:

Their willingness to roll over and tell spinmaster-generated lies is the principal reason why their successors as Republican economic policymakers will be scorned and ignored whenever the Republicans hold power--just as their predecessors' willigness to roll over and tell lies is the principal reason why they were scorned and ignored when they served in government.

The Feldstein-Taylor claim that likely set Brad off was the oft heard and never delivered proposition that a Republican Administration would pay for its promised tax cuts by drastically reducing the size of the government. Tax cuts financed by deficit spending, on the other hand, tend to reduce national savings and investment as noted here:

The McCain fiscal proposals amount to continued fiscal irresponsibility which will lower national savings leading to less investment and long-term growth. I’m shocked that these two gentlemen would lend their name to such free lunch supply-side silliness.

Since McCain nominated Sarah Palin to be his vice presidential running mate, the press has become more alert to their recent lies. I just wish that the press would spend more time on those supply-side lies that date back to the 1980 campaign by someone named Ronald Reagan.